L3C: Will the IRS favor Social Progress?

clip_image002.gifLast month at a peace rally, I saw a woman with a sign that read “where is my social progress?” and she got me thinking…. Where is social progress if not in socially active individuals? I thought of Margret Mead’s famous quote: “Never doubt that a small group of thoughtful, committed citizens could change the world. Indeed, it is the only thing that ever has.”
Inspired, I decided to take a plunge into social entrepreneurship and incorporate a new kind of socially beneficial company called an “L3C.” An “L3C” is an acronym for Low-profit, Limited Liability Company. An L3C is run like a regular business and is profitable, yet unlike a standard LLC, the L3C has primary charitable goals. To date, only Vermont and Michigan have ratified the legality of the L3C business model.
My L3C formation process was very simple. I chose a name “The Regenerative Group, L3C.” I filed the Vermont Secretary of State papers stating that my company’s charter is “to develop family education and outreach programs supporting the mission, vision and values of the sustainability movement”, and I paid the $75 processing fee with a check in the mail. I thought: “that was easy,” but I was warned: before I raise start-up capital and kick up my socially beneficial operations I should wait to hear what the IRS will say about the tax implications of the new legal entity: L3C.

The IRS ruling will be momentous because it will determine the ultimate fate of my L3C and others which have recently been formed across the country. I chose to incorporate an L3C because I believe in the underlying purpose. Let me explain.
And as the name states, the L3C can make a LOW Profit, but profit is not the primary purpose. Social “good works” is the mission of the L3C charter, with profits being a secondary concern. Yet, unlike a traditional charity organization, the L3C is free to distribute its low (1%-10%) profits, after taxes, to owners or investors.
The L3C is intended to be a “4th Sector Business” that brings together the three traditional economic sectors of: non-profit, public, and private sectors. That is, the L3C aims to synergize the interests and capital sources of (non-profit) private foundations, trusts, and endowment funds, plus government (public) entities, and other (for-profits) entities like pension funds, corporations, and individual investors – all into a L3C “4th Sector” hybrid organization designed to achieve social objectives while also operating according to for-profit metrics.
The purpose of the L3C hybrid structure is to use patient, long term, low return, or no return, philanthropic capital to entice market investors to build businesses that serve important social purposes. An example is a community L3C organization which sells locally grown fresh food in the inner city, thereby helping farmers and consumers, while also providing jobs and potentially building new schools with profits.
Yet again, the L3C is still in its “proof of concept” phase, but will be put to the test later this year. Because the first L3Cs were formed in 2008, this means 2009 will be the first year that the concept will be tested with the IRS. Hopefully, the IRS will readily accept Foundation investments in L3Cs as valid PRIs (Program Related Investments). If not, then L3C’s will not be able to receive tax deductible charity funds from large foundations, and will go the way of the Dodo. Yet, L3C seem to match all the PRI requirements.
Program-related investments (PRI) are those in which:
1. The primary purpose is to accomplish one or more of the foundation’s exempt goals
2. Production of income or appreciation of property is not a significant purpose, and
3. Influencing legislation or taking part in political campaigns on behalf of candidates is not a purpose.
L3C’s should (hopefully) satisfy the IRS’s definition of a PRI and thus stimulate more foundation funding and widespread social recognition of L3Cs. Other States can then hopefully follow Vermont’s lead and enact their own L3C legal recognition. This is how the LLC spread from Wyoming in 1977 to the entire Union.
The best case scenario for L3C’s social efficacy will be:
1) The IRS publicly recognizes the L3C as a PRI.
2) L3C’s will begin to be incorporated by individuals across the country
3) Foundations begin to flow money into L3Cs
4) Private “social responsible” investors will invest heavily in L3Cs
5) L3Cs will model “pure transperency” in their operations and financials
6) L3Cs will build and provide needed social services and ventures
7) L3Cs will stimulate more and more intentional “socially responsible” investing across all sectors of the economy
8) L3cs will further the beneficial efficacy of traditional non-profits.
Soon, time will tell. The IRS judgment should be known by the end of the year. I believe that the L3C can and will be an effective vehicle for creating a future that is more sustainable, bountiful, and socially equitable for the good of all American citizens.
For more information on L3Cs, see Vermont’s Secretary of State Website.
Brian Burnham Jones is a current MBA ’09 student at The LEEDS School of Business at the University of Colorado, Boulder. Brian’s MBA is focused on Sustainability and Entrepreneurship. Brian is seeking collaboration and support to further his L3C mission. Contact Brian at: Brian.B.Jones@Colorado.edu